Ch 8 Outline

8-1 Introduction
• Capital, revenue and cost are deeply intertwined—
actions taken to modify one component usually
have an effect on the other two.
• Launching a new venture normally requires an
infusion of capital during the early stages.
– Before capital can be raised, the venture must establish
a legal form that will enable it to solicit and raise debt
or equity capital.
– All entrepreneurs must decide what type of legal form
they should use as the structural basis of their company.
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Ch 8 Outline
1.
2.
3.
4.
5.
6.
Introduction
Sole Proprietorships
Partnerships
Limit Liability Companies
Corporations
Non-Profit Corporations
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Legal Forms of Ownership
1. Sole Proprietorship
2. Partnership
a. General Partnership
b. Limited Partnership
c. Limited Liability Partnership
3. Corporation
a. C-Corp.
b. S-Corp.
c. 5-1 c (3) (Not-for-Profit) Corp.
4. Limited Liability Company
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Popularity of Business Ownership
Forms
100%
80%
73%
60%
40%
20%
20%
7%
0%
Sole Proprietorships
Corporations
Partnerships
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8-2b Disadvantages of a Sole
Proprietorship
• Disadvantages of a sole proprietorship
include:
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–
–
–
–
–
Unlimited liability
Difficulty in raising capital
Limitations in managerial ability
Lack of stability
Demands on time
Difficulty in hiring and keeping highly
motivated employees
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8-2a Advantages of a Sole
Proprietorship
• Advantages of a sole proprietorship
include:
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–
–
–
–
–
–
Ease of starting
Control
Sole participation in profits and losses
Use of owner’s abilities
Tax breaks
Secrecy
Ease of dissolving
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Partnership—UPA’s Definition:
“An association of two or more persons, to
carry on as co-owners, a business for
profit”.
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General Partnership
Regardless of the percentage of the business they own, general partners
have authority to act and make binding decisions as owners of the
business. Each general partner is liable for all the debts of the business.
 Partners generally share profits and losses according to a plan specified
by an agreement between or among them.
With the authority to act as an owner, each general partner can engage the
partnership in binding agreements.
Unless a partnership agreement prevents a general partner from making
such agreements, the partnership is responsible for all actions of each
owner.
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Limited Partnership
All partnerships must have at least one general partner. A limited
partnership includes one or more general partners and one or more
limited partners.
The general partners arrange and run the business while the limited
partners are investors only.
The limited partner investors receive special tax advantages and protection
from liability.
These partners legally may have no say in managing the business. If this
requirement is violated, the “limited” status is dissolved.
These partnerships are usually found in service industries or in
professional firms such as real estate and dentistry.
They are also used extensively to enable various international
arrangements.
In some states, a special notice must be filed in the county or district in
which the limited partnership has its offices.
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Business Partnerships
General Partnerships
Limited Partnerships
Equal
Partners
Unequal
Partners
Share
Ownership
Unlimited
Liability
Passive
Investors
Limited
Liability
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8-3b Advantages of a Partnership
• Advantages of a partnership include:
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–
–
–
–
Greater access to capital
Combined managerial skills
Ease of starting
Clear legal status
Tax advantages
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8-3c Disadvantages of a
Partnership
• Disadvantages of a partnership include:
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–
–
–
–
Unlimited liability
Potential disagreements
Investment withdrawal difficulty
Limited capital availability
Instability
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Corporation:
A (separate) legal entity with the power to
own property and to conduct business.
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Corporations
Enter Into
Contracts
Own and
Sell Property
Sue and
Be Sued
Enjoy Limited
Liability
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Advantages of a Corporation
The power and presence of corporations in American business suggest that
this form has certain advantages over other forms of business
ownership:

Limited liability: A person investing funds in a corporation
receives shares of stock and becomes an owner.
o In a corporation, the liability for the shareholder equals the amount of
funds invested.
o Thus, if the business is forced to liquidate, each owner loses only the
amount of money he or she has invested.

Skilled management team: The board of directors has the duty of
hiring professional Managers, and the owners delegate their power of
operating the business to these managers.
o Professional managers are trained and experienced career executives.
o They may own shares of stock in the business but usually not enough
to control the corporation.

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Advantages of a Corporation (cont.)
Transfer of ownership: Shareholders have the right to sell their
shares of a corporation's stock to whomever they please,
barring a legal restriction on some closed corporations.
These shares of ownership can be sold whenever the shareholder
desires and at the price the buyer is willing to pay.
Greater capital base: The size of a proprietorship or partnership
is limited to the amount of capital that one or several people
have available and is willing to invest.
Corporations, however, can attract capital from a large number of
investors by selling shares of stock.
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Advantages of a Corporation (cont.)
Stability: State law varies, but a corporation can usually be chartered to
operate indefinitely. Shareholders' deaths, retirement, or sale of stock
need not dissolve the business.
The corporation's policies may be altered by the sale of large blocks of
stock, but the business will go on.
Nor will the death or retirement of the president of the board or the chief
executive officer stop the corporation from doing business.
 Legal-entity status: A corporation can purchase property, make
contracts, or sue and be sued in its corporate name.
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S-Corporations
To qualify as an S-Corp., a business must meet the following
requirements:
It must be incorporated within the U.S.
It can only sell one type of stock (common stock).
All shareholders must be natural persons, estates or trusts.
All shareholders must be residents of the U.S.
No shareholder can be a partnership or corp.
Some states limit the number of shareholders (usually to 100).
No more than 20% of its income can come from passive activities (e.g.
investing in shares of other corps.).
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Disadvantages of a Corporation
Difficulty and expense of starting. Starting a corporation involves
applying for a charter from a state.
o Each state has its own set of laws; these laws must be considered
before an entrepreneur decides where to incorporate.
o An attorney should be hired to complete legal forms. Attorney fees and
state charter fees must be paid.
o The chosen state then reviews the application and issues a charter that
specifies various restrictions on operations.
 Lack of control. The individual shareholder has little control over the
operations of the corporation except to vote for a slate of individuals
for the board of directors.
o The buying and selling of shares of stock is the only real control an
owner has.
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Disadvantages of a Corporation (Cont.)
Multiple taxation and fees. In addition to an annual franchise tax in the
state of incorporation, an annual payment is required by most states for
the right to operate as a corporation.
o No such fees are charged to a proprietorship or partnership. Some
states levy a corporate income tax on those monies earned within the
state.
o At the federal level, the corporation has to pay taxes on its profits.
Lack of secrecy. A corporation must provide each shareholder with an
annual report.
o In a closed corporation, the few reports that are circulated usually
won't get into the hands of nonowners.
o But when a large number of reports are issued, the reports become
public knowledge.
o Public disclosure enables competitors and other outsiders to see the
corporation's financial condition.
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Disadvantages of a Corporation (Cont.)
Lack of personal interest. In most large corporations, management and
o
o
o
o
ownership are separate.
This separation can result in a lack of personal interest in the success of the
corporation.
If the managers are also shareholders, personal interest is enhanced.
It is assumed that employees who are also owners will work harder for the
success of the business, but the accuracy of this assumption is an individual
matter.
Most managers have pride in their work and want any business they are
involved with to succeed.
Credit limitations. Banks and other lenders have to consider the limited liability
of the owners of a corporation.
o If the corporation fails, its creditors can look only to the assets of the business
to satisfy claims.
o For partnerships, the creditors can rely on personal assets of the partners to pay
off business debts.
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8-4 Limited Liability Company
• The limited liability company (LLC) is a
relatively new legal form that has now been
adopted in all fifty states.
– The LLC limits the liability exposure of all investors to
the amount of their investment.
• Anyone can participate in the management and still have
limited liability protection.
– To form a limited liability company (LLC), business
owners must file formal articles of organization with
their state's LLC filing office and comply with other
state filing requirements.
• LLC can have an unlimited number of investors, known as
members.
• It is also required to prepare an operating agreement.
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8-4a Advantages of a Limited
Liability Company
• Advantages of a limited liability company
include:
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–
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Limited liability
Pass-through taxation
Investors can manage
Unlimited membership
Ease of organizing
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8-4b Disadvantages of a Limited
Liability Company
• The disadvantages of an LLC are due primarily to
its relatively recent adoption by state legislatures.
– Many people still don’t understand it well, and courts
have only begun to form a record of common law.
• Other disadvantages include:
– Difficulty raising money
– No continuity of life
– Limited transferability
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